When your debts become more than you can manage each month, especially your credit card payments, one option many people consider is a debt consolidation loan. Like every approach to managing what you owe, consolidation loans have pros and cons — including the chance that a lender may not approve your application due to your circumstances.
If you’ve been turned down, you may wonder what factors lenders consider in evaluating a consolidation loan application, what you can do to improve your chances for approval in the future, or what other options you can consider.
WHAT IS A DEBT CONSOLIDATION LOAN?
A debt consolidation loan is a new loan where you use the funds you receive to pay off existing unsecured debts, such as credit card balances. Lenders usually charge fees for making a consolidation loan. Almost always, you’ll be required to close the accounts you pay off.
In return, you’ll consolidate your payments into just one per month instead of all the individual payments you had been making. If you’re able to get a low interest rate on your loan, you may be able to save a lot of money.
If you’re considering a consolidation loan, be sure to understand the pros and cons vs. other options such as a debt management plan.
WHY LENDERS DENY DEBT CONSOLIDATION LOAN APPLICATIONS
When lenders evaluate a consolidation loan application, they look at a variety of factors including your credit score, the amount of debt you’re carrying, your income (both how much you earn and how long you’ve been in your current job), and the length of your credit history.
A loan denial usually is due to one of two issues:
POOR CREDIT SCORE
The top reason banks and other lenders deny a consolidation loan application is the applicant’s poor credit score. Your credit score is a number that represents how risky you are to the lender. The most well-known credit scoring model is from FICO, which has a score range of 300-850, with anything under 580 considered poor credit and anything above 800 considered exceptional credit.
A low credit score may not automatically disqualify you for a consolidation loan, but a good score greatly improves the likelihood your application will be approved.
INABILITY TO MAKE LOAN PAYMENTS
Lenders take a holistic look at your financial situation, including your income and any other debts (a mortgage, car loan, or student loans) to determine your ability to repay the loan. If they run the numbers and don’t feel you can afford the monthly payment, it’s very likely you’ll be turned down.
Lenders need to feel confident you’ll be able to make the payments on a loan they give you. While lenders may offer a longer repayment period to bring down monthly payments, that timeframe generally does not extend beyond 72 months (six years).
HOW TO IMPROVE YOUR CHANCES OF BEING APPROVED FOR A CONSOLIDATION LOAN
If you’ve been denied a consolidation loan, you’ll want to take a hard look at the same factors your lender considered, then make improvements. Focus on these goals:
BRING UP YOUR CREDIT SCORE
If you have poor credit, a first step is understanding your credit report and your credit score to identify the best opportunities for improving your credit score. While there are no immediate fixes, you can work toward a better score over time. Rebuilding credit with alternative data, such as rent payments and utility bills, is one way to work toward a better score sooner, although this approach usually involves fees.
MAKE PAYMENTS ON YOUR CURRENT DEBTS
Keep track of when payments are due on your accounts and be sure to make those payments on time. Payment in full is best but making the minimum payment by the monthly deadline is far better than a late payment or, worse yet, no payment at all.
PAY OFF SMALL DEBTS FIRST
To get some solid wins on your credit report, try to pay off the accounts with the smallest remaining balance. Reducing your overall debt will also reduce your debt-to-income ratio, which shows what percentage of your total income goes to payments on your debts. Lenders may not be willing to extend you credit if too much of your income is tied up in debt payments.
You may also want to target accounts where you’re at or near the account balance. Paying down maxed out accounts can help improve your credit utilization ratio, which shows what percentage of your available credit you are using and is a factor in most credit scoring models. The lower the ratio, the better it is for your credit.
MAINTAIN A STEADY SOURCE OF INCOME
Lenders are looking at what income you have available to make the monthly payments on the consolidation loan. Holding a steady job with a steady (or increasing) income will help demonstrate your ability to make payments. In addition, remaining with the same employer will help show stability and reliability, which reduces risk in the eyes of most lenders.
DON’T ADD NEW DEBT
Adding new debt accounts may have a negative impact as a lender considers your application. Remember, a consolidation loan is intended to manage debt from multiple accounts, and you’ll be required to close the accounts you’re paying off. Adding new debt will not help a lender feel confident that you’ll be able to manage all of your financial responsibilities.
HOW TO FIND A REPUTABLE DEBT CONSOLIDATION LOAN AND AVOID A SCAM
If you feel a debt consolidation loan is the right choice, you’ll want to make sure you find a reputable lender and avoid a scam. Many disreputable lenders are eager to take unfair advantage of people who are struggling with debt. The more difficult your situation, the more likely you are to encounter a predatory lender.
Follow these tips for finding a good consolidation loan from a reputable lender.
SHOP AROUND FOR CONSOLIDATION LOAN OFFERS
Start with the bank or credit union where you already have accounts and ask what they can offer you. You’ll want to look at what interest rate is available and what your monthly payment would be. While a lower monthly payment is very attractive, you’ll want to make sure the interest rate offered is low enough to save you money versus what you’re already paying on the debts you want to consolidate.
CONSIDER ONLINE LENDERS
Some are reputable, but others are not. It’s important to know the pros and cons of borrowing from an online lender and be well informed when you consider their offers. Read online reviews to see what other loan applicants or customers have to say about their experiences with an online lender. You can also check with the Better Business Bureau for ratings or information about consumer complaints.
COMPARE MULTIPLE CONSOLIDATION LOAN OFFERS
Many legitimate lenders offer loans for people with poor credit. But when an offer sounds too good to be true, it’s likely that it isn’t in your best interests. By researching heavily and obtaining multiple offers, you’ll be in a good position to recognize a good, solid loan as opposed to one that’s potentially predatory.
WHAT ARE THE BEST ALTERNATIVES TO A DEBT CONSOLIDATION LOAN?
If you’ve been turned down for a debt consolidation loan or are worried you will not be approved, you have other options to consider.
DEBT MANAGEMENT PLANS
A debt management plan (DMP) is a form of consolidation that doesn’t involve a loan or require a credit check. For unsecured debt like credit card balances, DMPs offer a structured repayment program in which you make a single payment to a nonprofit credit counseling agency (such as MMI) which then disburses funds to your creditors on your behalf. The accounts you’re paying off on a DMP will be closed.
In return for working with a nonprofit counseling agency, most major creditors offer significant interest rate reductions for accounts included on a DMP, which can save you a lot of money over the course of the DMP. Additionally, most DMPs are completed in less than five years.
As part of a DMP, the credit counseling agency will teach you about managing money and provide ongoing counseling to help ensure you don’t fall back into the spending patterns and habits that led to the need for debt consolidation in the first place.
SETTLEMENT OR BANKRUPTCY
If your financial situation means you cannot afford to make payments on your current debts or a debt consolidation loan — and a debt management plan is not a good fit for you — your options are limited. You may want to explore a settlement, in which creditors accept less than the amount you owe, or consider filing for bankruptcy. Bankruptcy is a complex decision that will impact your life for years to come and should be evaluated very carefully before moving ahead.
WORK TOWARD A LONG-TERM PLAN TO MANAGE YOUR DEBT
Consolidating debt can be a very helpful tool if you’re struggling to make payments on what you owe. Before selecting the best approach to consolidating debt, think through the factors that led to your situation. If your issues are with spending or budgeting, debt consolidation may be just a temporary solution to a major problem that will continue if you don’t address it.
As you determine the best option, make sure you have a sustainable plan to pay off your debt without adding more debt. You should feel confident that you’ll be able to manage your payments and reach the end of your loan, debt-free.
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